This Food Stock Looks Attractive

By Gayatri Sharma - September 25, 2012 | Tickers: CAG, HNZ, KRFT | 0 Comments

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ConAgra Foods (NYSE: CAG) recently reported a great quarter, with EPS of $0.44 exceeding consensus estimates of $0.36. The EPS beat was clean, with no meaningful assistance from taxes or interest expense. Sales growth was 6.7% as compared to the consensus estimates of 5.4% and the gross margins were impressive as well, at a pro forma 22.5% versus consensus’ 21.1%. Moreover, the management increased its full year F2013 EPS guidance to a range of $2.03-$2.06 (10%-12% growth) as compared to the consensus estimates of $1.98 and up from prior guidance of $1.95-$1.99 (6%-8% growth).

In conjunction with its earnings release, the company announced that its Board of Directors has approved a $0.01 increase in its quarterly dividend to $0.25 per common share. At an annualized rate of $1.00 per share, the new dividend yields approximately 3.7% at current prices. The new dividend is payable on December 4, 2012 to all shareholders of record on October 31, 2012. ConAgra’s dividend yield is highly impressive considering that it is trading at a relatively inexpensive valuation versus its peer group. Let’s compare the dividend yield and valuation multiple of ConAgra with H. J. Heinz Company (NYSE: HNZ) and Kraft Foods (NASDAQ: KRFT).

Thus, despite trading at the least valuation ConAgra provides the best dividend yield among these companies. Moreover, a P/S ratio of 0.79 and a growth rate of 11.14% (assuming the mid-point of the EPS guidance range of $2.03-$2.06) make it look significantly undervalued as compared to its peers in the food products industry.

We often hear about big acquisitions and mergers in the U.S. business environment, but recently things have been going the other way with Sara Lee Corporation already spitting up into two separate businesses and Kraft Foods also set to spin-off its grocery business in North America from its snacks business. Following the industry’s current trend, we may very well see a value enhancing corporate slit-up from ConAgra as well. If the company makes any such announcement which I believe has a strong likelihood, it will act as a positive catalyst for stock appreciation.

While volume is expected to decline modestly for the year, I believe the significant increase in marketing spending and new product innovation should lead to sequential volume improvement, particularly in 2H13, which indicates improved visibility compared to worsening visibility for peers. Despite the recent surge in grain prices, the company now expects inflation in its Consumer Foods segment to be lower than the mid-single digit range originally anticipated in FY2013, reflecting the company’s hedging and procurement strategy as well as the nature of its raw input needs.

In addition, the company has been pro-active on the acquisition front. ConAgra’s recent acquisitions of Bertolli and P.F. Chang’s will provide a good support to its heavily dinner-focused product offering with items that will strengthen ConAgra in alternate channels. These acquisitions are highly overlapping and would result in significant cost synergies over time. Going forward, I think the company will look to leverage its balance sheet to create shareholder value with a combination of buybacks, acquisitions, and dividends.

I rate ConAgra's shares buy as I believe the worst is behind the company and management has done a good job in increasing the company’s advertising budget and new product innovation, which has boosted sales growth trends at the company. Moreover, management has committed to pursue growth through strategic acquisitions, and also has undertaken restructuring efforts aimed at reducing the complexity of the company and improving its efficiency. As a result of these factors, ConAgra appears poised for earnings growth.

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